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Good news on bad loans
Updated:Oct 11, 2017
 
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By Manish Sabharwal
 
In 1990 as a fresh graduate, I quickly realised that successful businessmen spent much of their time in Delhi because the licence raj ensured companies did not have customers but hostages. In 1996 as a fresh MBA seeking advice on becoming an entrepreneur, a licence-raj era tycoon told me to forget my western concepts of Return on Equity but think about Return before Equity — the money left from over-invoiced projects funded with nationalised bank loans after you accounted for the bribes to get the loans, real capital expenditure and your official equity contribution. In 2007, as an entrepreneur seeking advice on making my second company bigger than my first, another tycoon told me “I’ve got a Rs 3,000 crore loan disbursal today; I’m a cash rich company” — I guess he believed the difference between liquidity and solvency was a western concept.
 
 
A lot of pre-1991 entrepreneurship was sustained by the toxic troika of the licence raj (low competition), IPO market control (equity scarcity), and nationalised banks (excess leverage). The first two began ending in 1991 but not tackling the third weaponised the scale of crony capitalism. In fact, concentrated lending by nationalised banks after 1991 became an area of “social silence” — to use the concept of French sociologist Pierre Bourdieu — where cronyism was hidden in plain sight. I’d like to make the case that current changes to bankruptcy and bad loan resolution are not a passing shower but climate change for Indian entrepreneurship. And an important tool in the broader battle against corruption.
 
 
The toxic troika distorted the relationship of business and politics with painful consequences. Pre-1991 businesses got licences and loans by specialising in regulatory connections, professionals were poorly paid and shabbily treated, consumers suffered poor quality at high prices, and India became a hostile habitat for first generation entrepreneurs. Bank nationalisation was well intentioned; on July 21, 1969, the prime minister told Lok Sabha “Bank nationalisation is needed to ensure that the needs of farmers, small-scale industrialists and the self-employed are met in increasing measure”. But banks have a large problem: Today 12 companies have defaulted on loans more than Rs 2 lakh crore, one bankrupt steel company has more loans than our central government allocation to primary education, and non-farm and non-SME bad loans may be more than Rs 10 lakh crore.
 
 
The 1991 end of the licence raj meant younger and hungrier companies outperformed traditional “groups” because animals bred in captivity found it hard to live in the jungle. The 1992 abolition of the Controller of Capital Issues created a private equity industry whose $150 billion cumulative investment created the bigger and better governed companies that are creating IPO market vibrancy. However, not dealing with the human capital and governance challenges (board and management accountability, phone calls, lack of specialisation, transfers, etc) at banks allowed a few borrowers to not only borrow unreasonable amounts but created a vested interest in bad loans not being revealed, recognised or resolved.
 
 
 
The process to end this culture of immunity and impunity has begun. The government passed the Insolvency and Bankruptcy Code (IBC), SEBI directed immediate loan default disclosure for listed companies (regrettably deferred but not abandoned), and the RBI has forced banks to use IBC provisions. The IBC is clever legislation that recognises all failures are not fraud (reasons could include unrealistic ambition, policy inconsistency, regulatory failure, etc), separates financial and operational viability, ensures high negotiating human capital for borrowers, and uses deadlines to prevent bankruptcy being perpetual or terminal.
 
 
 
Resolving bad loans is important for many reasons. Stories like “chotte chor se akalmand bada chor” (a big thief is smarter than a small thief), “imaandar udhaar lene waala bewakoof” (an honest borrower is a fool), and “agar seth ka karza maaf to kisan ka kyon nahin” (if loans are forgiven for business, then why not for farmers) are economically corrosive. A modern state is a welfare state and freeing up government finances from nationalised bank recapitalisations is urgent. I am not suggesting that state ownership of banks should go; the global financial crisis is evidence that private ownership is no guarantee of prudence. But we need lasting solutions to the recurring capital calls on government money desperately needed in other areas. Finally, restoring the romance of policy — the state being viewed as a force for good rather than an accomplice in perpetuating a crusted, connected and dynastic elite — is overdue because reforms are not about goofy rich guys buying BMWs but roads, power, education, and median household income.
 
 
The RBI’s involvement in bad loan resolution has been unfairly criticised as “conceptually indefensible”. The RBI’s decisive, precise, and transparent actions to operationalise the IBC mean it is doing the job of banks, their boards and their shareholders. The RBI’s well-deserved reputation for integrity and competence is being reinforced by treating all banks equally, thinking ahead, and letting actions speak louder than words. India is best served by a central bank that continues to talk less, takes the long view (daily banking system balances are up by more than Rs 2 lakh crore since last November), and aims to be successful rather than right.
 
 
India’s entrepreneurs are already raising more equity (debt to market cap is declining), bearing more consequences of their actions (I own 20 per cent less of my company than I could have because of an arrogant acquisition that went wrong) and earning or raising equity rather than borrowing or stealing it (most of my cohort owns between 15-25 per cent of our companies relative to the listed company average of 50 per cent). Bad loan resolution and bankruptcy are crucial in shifting India from Return before Equity to Return on Equity. This shift will make the Indian economy fairer, less corrupt, and more innovative.
 
 
Lord Mountbatten once told Gandhiji that fear is contagious. He responded, “So is courage”. Banks must seize this policy window created by policy courage.
 
 
 
 
 
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